When hearing about a concept called crowdfunding for the first time, your initial reaction may be that this sounds like some kind of platform that Bernie Sanders ran on for president in 2016. To sum it up in a nutshell, people give your business money and expect nothing in return. Amounts from one hundred dollars to hundreds of thousands of dollars are given by “backers” to get involved with your business. One must ask themselves, why?
There are a plethora of crowdfunding sites like Indiegogo and Kickstarter. Looking at these two websites in particular, you would guess that this is mostly non-profit, perhaps political type of stuff that you can get involved with. But as you see in the chart above, almost half of this type of funding is for-profit businesses. I read long and hard on the Indiegogo site about funding, and it never clearly defined what funding was, is it a donation, an investment or what.
Crowdfunding is a multibillion dollar industry, and is basically divided into two parts. Those that give or donate money, backers as they call them, who expect little in return, and equity funders, who take a financial position in your start-up. Let’s look at each a little deeper.
- Funding as a Donor: With this approach to crowdfunding, people contribute small amounts of capital to fund your new business, product or concept in return for specified rewards. This can be anything from a personal phone call to a trip to Paris. More times than naught, it’s closer to the personal phone call. There is not a lot of downside financially to this type of crowdfunding. You aren’t expected to pay it back and have set no goals or thought through a realistic business plan. This is where the downside comes in. Yes, you can get money in dribs and drabs if you have a colorful scheme and an interesting idea. However, at the minimum, with any conscious at all, you have a certain non-financial obligation to those donors to make something happen. Also, it is highly unlikely that a handful of people giving you $50 is going to gain you segue into areas like target marketing, sales, secondary funding, etc.
- Equity Crowdfunding: This is slightly more mainstream. Investors give you money; you give them an ownership stake in your business based on how much they contribute. The primary advantage of this approach is that it gives you easier access to savvy angel investors who, in addition to funding, can also offer experience and expertise that greatly increase your chances of success. Equity crowdfunding also tends to attract more serious investors, making it easier to raise larger sums of money. The financial expertise at these start-ups varies quite dramatically. One such start-up looking for about a million dollars on a crowdfunding site had 11 employees, none of which had any financial knowledge, and only one actually produced a resume. This is from the investor’s perspective, of course, but it relates to mindset and the effort that you need to put into your crowdfunding offer if you do so.
Here’s the thing. Realizing your dream as an entrepreneur is hard. Granted, funding can help supplement other sources of money and help you try out a product, but the true test of a business is what happens after the funding is done. Crowdfunding from a donations point of view can be problematic. It doesn’t force you to possess the key attributes of a successful entrepreneur. You’ll need the discipline, expertise and sense of urgency that only comes putting your own money at risk or that of serious investors who expect a real return. Caveat emptor.